MT217-03 Finance Class Notes .docx - MT217-03 Finance Class Notes Professor Richard Carter Unit 10 Discussion Stocks There are two primary means to earn

MT217-03 Finance Class Notes .docx - MT217-03 Finance Class...

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MT217-03 Finance Class Notes Professor Richard Carter Unit 10 Discussion: Stocks There are two primary means to earn income as a stockholder. The first method is dividend income and the second method is earnings from capital gains. With respect to the investor seeking dividend income, when the investor buys a stock from a corporation with a primary focus to earn dividend income they will typically expect a higher dividend on common stock versus preferred stock. Discuss the dividend payment requirements of a common stock versus preferred stock, in terms of which type of stock has a primary claim on dividend distributions. Explain why the common stock investor demands a higher dividend rate. Response: The greatest advantage of a preferred stock is that its claim to a company’s assets and earnings are greater and have higher priority than a common stock. When there are dividends to be distributed, preferred stockholders get paid before common stockholders, and if a company must liquidate, preferred stockholders are first in line to get paid. If there’s money left after preferred stockholders get paid, then common stockholders get paid. Owners of preferred stocks also know when to expect dividend payouts, because they come at regular intervals. The reason common stock investors demand higher dividend rates is due to the risk involved. There is higher risk for common stockholders as a result of payout prioritization, since in the case of a company needing to liquidate, there’s a chance that common stockholders won’t get paid at all. References Eakins, S., McNally, W. (2014). CFO Corporate Finance Online . NJ: Pearson Education Unit 9 Discussion: Bonds There is an inverse relationship between bond prices and yields. This inverse relationship will be demonstrated by calculating bond prices to show that interest rates move inversely: if yields rise, then bond prices fall. Bonds will be sold either at a premium or a discount. With this in mind respond to the following question. You currently own a 30 year Treasury Bond at 4% interest, paid semiannually. The market interest rates for like securities rose to 5%. Would your bond sell for a premium or a discount? Why? What would the market value of your bond be? Prove your answer by showing your work. Response: Assuming the bond has a face falue of $1000, the market value would be $845.46. Given Values Translated Values
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FV $1,000 FV $1,000 Rate 4% Rate 5% Current Rate 5% Nper 60 (30 years, twice per year) No. Years 30 Pmt $20.00 (1000 * 4% / 2) No of periods/year 2 Formula for PV = (rate: 5%/2, nper: 60, pmt: $20, fv: $1000) PV $845.46 Because the interest rate went up from 4% to 5%, the bond would be sold at a discount, because it’s value is less than that of the current market. It would be sold at a discount. In our text book, Eakins & McNally point out that “Bonds with coupon rates lower than their yields trade at a discount.” One thing to note is that as the maturity date approaches, the price gradually rises (Eakins & McNally, 2014, p. 324).” References Eakins, S., McNally, W. (2014). CFO Corporate Finance Online . NJ: Pearson Education
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